Impact of the Mexican oil and gas bill

FW: Could you provide an overview of the current state of the Mexican oil and gas industry? How significant is new legislation for the energy sector?

Serra: The oil industry is currently run by the state agency Petroleos Mexicanos (PEMEX) with minimal private sector participation in related activities such as processing, distribution and marketing of gas activities, gasoline sales to the public through service stations, and the development of secondary petrochemicals. The reform of the energy sector published on 20 December 2013 is significant because it will allow direct private sector participation in the exploration and extraction of oil and hydrocarbons – mainly in areas that previously PEMEX has been unable to develop – such as in deep water and shale gas – due to lack of appropriate technology and financial capacity.

FW: Mexico is the globe’s tenth-largest oil producer. Why are such legal reforms required? What factors have driven legislative change?

Serra: According to information from the Ministry of Energy, in the last 10 years PEMEX has seen a fall in production in virtually all operational activities. This has occurred for several reasons, including the depletion of natural resources, a lack of investment in various areas of production, and a lack of technology required for the exploration and exploitation of oil and hydrocarbons. To give some examples, oil production increased between 2000 and 2004, reaching a peak of 3.3 million barrels per day. Since then it declined to a level of 2.5 million in 2012, despite investment in exploration and production that tripled from 77.86bn pesos in 2000 to 251.90bn pesos in 2012. Between 2003 and 2012, proven oil reserves decreased by 31.2 percent from 20.077 billion barrels of crude oil equivalent (MMboe) to 13.810 MMboe. In the same period, probable reserves decreased by 27.2 percent, from 16.965 MMboe to 12.353 MMboe. As for end products, Mexico has become a net importer of gasoline, diesel, jet fuel, natural gas, liquefied petroleum gas (LP) and petrochemicals. Given the circumstances, structural and institutional changes were necessary and made through an amendment implementing the objectives of a modern energy policy: security of supply, competitiveness, sustainability and fiscal viability. As the current management of the sector had reached its limits, endangering energy security, public finances, social programs and the quality of life of Mexican society, a change to the system was urgently required.

The Energy Reform provides for private participation in exploration and exploitation of oil and hydrocarbons through a scheme of broad and flexible contracts.

FW: What new freedoms does the bill grant to private investors and parties? What controls does the government retain?

Serra: The Energy Reform provides for private participation in exploration and exploitation of oil and hydrocarbons through a scheme of broad and flexible contracts. The reform approves procurement contracts including service contracts, shared utility contracts, production sharing contracts, licence agreements, or a combination of the above, however, the details of the content and scope will be determined by secondary legislation which should be published in a period not exceeding one year. Moreover, the nation will remain the owner of hydrocarbons and this must be made clear in the contracts mentioned above. The state will have control over such contracts through the Secretary of Energy, which will be responsible for entering into those contracts, with the assistance of the National Hydrocarbons Commission, which will be responsible for requesting tenders. The reform also involves a new trust, the Mexican Petroleum Fund, which will be responsible for receiving, managing and distributing the income from contracts – excluding taxes – and making payments of consideration under the contracts.

FW: The proposed ‘licences’ offered under the new reforms appear very similar to the ‘concessions’ that opponents on the left have long feared. How do they differ in reality, and how can the idea be sold to opponents of the bill?

Serra: In accordance with Mexican legal doctrine, through a concession, a third party is given ownership of something considered to be the property of the state for its exploitation and exclusive use during the time stated in the concession, in exchange for a higher rate of return for the state and for the community. The concession allows the use of the property and the benefits produced by it for a certain period of time, granted by the state. Unlike a concession, the licence scheme adopted in the reform considers the nation as the owner of the petroleum and hydrocarbons only until extraction from the subsurface, after which the property is transferred to private parties for consideration.

FW: Could you briefly explain the proposed profit-sharing arrangements for private parties? How will such schemes operate in practice?

Serra: The reform considers several models, including profit-sharing contracts, by which the state will grant private parties a percentage profit as compensation, although the details of this will be reflected in secondary legislation. According to the reform, it can be concluded that, in practice, contracts may be entered into by both the Ministry of Energy, as a representative of the nation, and PEMEX, brokered in both cases by the National Hydrocarbons Commission, which will carry out the necessary bidding process.

The reform has been overwhelmingly welcomed by investors, along with the industrial and commercial sectors in Mexico and the international community as a whole.

FW: How has the bill been received by energy firms, investors and the public at large? What have been the major criticisms?

Serra: The reform has been overwhelmingly welcomed by investors, along with the industrial and commercial sectors in Mexico and the international community as a whole. Overall, it has only found a few critics and some small radical resistance groups within the Mexican left, found mainly in the Party of the Democratic Revolution and the Labour Party. These have not had any significant impact. The most relevant critics are those that assume that private participation in the exploration and exploitation of hydrocarbons will result in the loss of national sovereignty to foreigners. It has also been argued that opening the sector is unnecessary and modernising and redesigning PEMEX should be the priority which, by itself, can deliver better results.

FW: What opportunities will opening up Mexico’s energy market provide for foreign investors? What benefits will the sector gain from their involvement?

Serra: Following the reform and secondary legislation waiting to be adopted by Congress, the private sector is able to participate in the exploration and exploitation of oil and hydrocarbons. Essentially, investment opportunities will be open in areas wihch PEMEX has not been able to take advantage of on its own. An example of this is the exploration and exploitation of hydrocarbons located in deep water, particularly in the Cinturón Plegado Catemaco field, with a possible range of five to 15 billion cubic feet of gas and shale gas. Five potential basins have been identified in the northeast, along the coast of the Gulf of Mexico, which will be entrusted to the private sector. With private participation and open competition, the sector will gain by attracting foreign capital that will result in the development of cheaper, cleaner petroleum products and encouraging the development of the energy production chain. This will drive economic activity in different regions of the country and job creation, the competitiveness of PEMEX will rise, and there will be more resources for the budget and social programs.

The reform is intended to transform PEMEX into a productive state enterprise, adopting the best international practices in its organisation, administration and structure, thereby ensuring its technical and managerial autonomy, under conditions of tighter fiscal mechanisms, transparency and accountability.

FW: In recent times Mexico’s national petrol producer, PEMEX, has been accused of corruption, cronyism and mismanagement. How far will the new reforms go toward remedying any malfeasance within the company and restoring its reputation?

Serra: The reform is intended to transform PEMEX into a productive state enterprise, adopting the best international practices in its organisation, administration and structure, thereby ensuring its technical and managerial autonomy, under conditions of tighter fiscal mechanisms, transparency and accountability. Moreover, the reform requires Congress to make changes to the regulatory framework of the industry in order to put in place adequate legal mechanisms to prevent, identify, and punish contractors, those holding permits, public servants, and any individuals or companies, domestic or foreign, participating in the energy sector whose conduct is intended, directly or indirectly, to influence the decision making of public servants or independent members of the board of directors of PEMEX.

FW: The new proposals are currently under the scrutiny of federal legislators and bureaucrats. What legal challenges are expected to arise before the reform is implemented?

Serra: The main legal challenge now is the approval by Congress of secondary legislation which will develop the content of the transitional provisions of the reform. This implies, among other things, the conversion of PEMEX into a state production company as well as changes to agencies or regulatory bodies, such as the Department of Energy, the National Hydrocarbon Commission, and the Energy Regulatory Commission, and the creation of new bodies such as the National Control Center and the Mexican Natural Gas Petroleum Fund. According to recent statements by the Secretary of Energy and the Director of PEMEX, it will be necessary to amend some 23 statutes and regulations, something which will require attention to detail and dedication in order to achieve a harmonised and coherent set of legislation. Another important aspect will be the appointment or renewal of public officials in these bodies and regulatory agencies, as well as the appointment of independent members to the board of directors of PEMEX. This will raise intense debate among political forces in Mexico.

FW: Do you expect the reforms will be implemented in their current shape? What impact do you believe these reforms will have on the energy sector going forward?

Serra: At present there is no information available about proposed draft secondary legislation, however its meaning and purpose will be to give form and content to amended Articles 25, 27 and 28 of the Constitution and 21 transitional articles, all approved in the Energy Reform. We believe that this reform will have a major impact on the sector, considering that it will make possible the exploitation of subsoil resources that it has not been possible to use so far, and open up the sector to competition with all the benefits that this implies for the population.

Juan Carlos Serra is a partner at Basham, Ringe y Correa, S.C. His specific experience includes joint-ventures, mergers and acquisitions, reorganizations, investments, acquisitions, as well as extensive advice in energy and mining issues. Mr Serra is an active member of the Mexican Legal Bar, Institute of Energy Law, and The International Bar Association (IBA). He is recognised by the Latin American Energy and Infrastructure Guide as a ‘Leading Lawyer’, and ranked in Chambers Latin America as a leading lawyer in Energy & Natural Resources, Mergers & Acquisitions and Real Estate practices. Mr Serra can be contacted on +52 55 52 61 04 91 or by email: serra@basham.com.mx.